Tuesday, January 27, 2009

Relative Volume and Movement in the Stock Market

If you take a look at my Twitter comments during today's trade, you'll see that I referred to the session as a "shit show" for intraday traders, as volume and movement tailed off ahead of tomorrow's FOMC announcement. That Twitter post was around 10 AM CT and was designed to help traders avoid making grand assumptions about the market movement to come. As you can see from a two-day chart of the ES futures (top chart above), today's market was narrow indeed, an inside market that offered opportunity only on moves from the edges of the ranges back toward the midpoint.

I've seen many traders lose a bundle of money on days like this, playing for breakout moves and getting chopped up. A great way to avoid overtrading markets such as these is to track relative volume: today's volume as a function of recent, average volume. In the bottom chart above, I plotted the recent median volume in blue (those numbers came from my Monday AM indicator post) and today's volume in pink. Notice how the pink line increasingly falls short of the blue one, as volume today tailed off relative to expected, median volume. We know that volume correlates well with volatility, so recognizing the slowing market was key to scaling back price movement expectations during the day.

Plotting today's volume during the day versus the "expected" volume is a great indicator, as you can see crossovers--points at which today's volume accelerates or decelerates relative to usual--and divergences, where today's volume either meaningfully exceeds or falls short of average. These patterns tell us how much movement to expect in the market, which in turn can help us in placing stops and setting price targets for trades. In my case, the relative volume told me to stay out of the market late in the day; it wasn't my kind of trade. Sometimes good trading is simply holding onto your capital.

I will be updating weekly relative volume benchmarks each Monday before the open and, when I'm not tied up with traders, will post real time relative volume observations via Twitter (subscription via RSS is free)..

Hi BrettYou said the following "Plotting today's volume during the day versus the "expected" volume is a great indicator, as you can see crossovers--points at which today's volume accelerates or decelerates relative to usual--and divergences, where today's volume either meaningfully exceeds or falls short of average"

Would it work if you set a moving average of past volume as the usual? What sort of value should we use ie a 20 ma or 50 ma? How else could you get a value for this amount if this is not the way to do it?

Thanks; I suppose a 20-day MA of volume vs present could offer a reasonable and simple benchmark as long as the times of day added and deleted to the average are the same. Partial trading days might mess that up--

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), and The Daily Trading Coach (Wiley, 2009) with an interest in using historical patterns in markets to find a trading edge. I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab).